Week 5

Question 1

Stress testing and it’s objectives

Answer 1

An evaluation of the financial position of a bank under severe but realistic circumstances to support management decisions

Objectives :

Testing capital adequacy under stress
Testing sufficient liquidity under stress
Understand the other risk types under stress
Initiating management actions in response to finding
Accountability to regulators, rating agencies and external auditors

Question 2

Stress testing governance

Answer 2

Determine the purpose of the stress test

Addressing accountability within the organisation

Involvement of senior management (directors ; risk ; business )

Intrinsic motivation : bank should want to know the performance under stress

External - EBA guidelines, DNB stress test , stress rating agencies

Internal - Different types of risk , integrated stress testing

Question 3

Different types of stress tests

Answer 3

Idiosyncratic - bank specific situations in a stable environment

Market specific - Environmental stress (financial, economic , government )

Question 4

Liquidity stress test

Answer 4

Basis is the actual liquidity planning / forecast

Determining stress situation (which kind of stress)

Determine impact on various balance sheet items (in and outflows

Determine consequences for the liquidity buffer

Calculate survival period

Designate recovery actions

Question 5

Capital stress test loan portfolio

Answer 5

1) Basis is the capital calculation based on PD LGD EAD
2) modelling these variables under stress (economy, unemployment etc)
3) calculate stressed PDs,LGDs
4) calculate new capital requirements with new stressed RWA values
5) calculate impact (delta) on core tier 1 ratio
6) desígnate “recovery actions” (credit risk mitigating factors )

Question 6

Stress testing interest rate risk

Answer 6

1) Difference between interest margin (RM) and result financial transactions (RFT)

2) Determine the period of the stressed interest margin (forecast)
- provide a good basic model
- robust, flexible , efficient
- input from the business (commerce,treasury)
- Economic forecast yield curve (base)
- pricing interest rate products

3) determine the stress variables
- stressed yield curve
- stress at commercialism, stress in the market (wholesale)
- pricing (price war )

Question 7

Impact of stress on

Capital :

P+L

And deductions

Answer 7

Net interest income (Decreases)
-increasing interest rates = short term higher interest costs

Commissions (decrease)
-financial markets fall = asset under management lower, fewer transactions

Costs remain the same

Profit financial transactions (decrease )
-decreasing financial markets, less profit

Impairment loan book (decrease ) downgrading causes more credit impairments

(May be significant - principal risk)

Deductions :

Loss is a direct deduction on capital

Basel 3 - stricter regulation - more deductions on capital

Shortfall deduction (difference EL and provisions )

Question 8

Impact of stress on

RWA:

PD LGD

OTHER

Answer 8

PD increases in stress scenario (lower GNP,Higher unemployment, higher interest rates )

LGD increases through lower collateral value (eg value of homes / real estate / shares / bonds)

Result

Higher RWA

Other risk
RWA for market risk will increase by increasing volatility

RWA for operational risk may increase due to increased risk (at least equal )

Depending on the value development - impairments on investment portfolio